Investing: New highs don't mean you have to sell

John Waggoner

Most people suspect that something bad is going to happen, particularly when things are going well. About to sell a house? The inspector will find a nest of 6-foot-long termites just before closing. About to cash in your lottery winnings? The ticket will spontaneously combust. Live in the most prosperous nation in history? A large monster will stomp all its cities flat.

Wednesday and Thursday, the Standard and Poor's 500-stock index hit all-time highs. Calm down. It doesn't mean the permanent destruction of your wealth. While there are many valid reasons to sell stocks — which we'll talk about in a bit — a new high in the S&P 500 isn't one of them.

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New market highs are unnerving, of course, because the next bear market will start at one of them. You just don't know which one. Had you invested in the market at its all-time high of Oct. 9, 2007, for example, you would have been deeply unhappy. On that day, the S&P 500 hit 1565.15, a level it didn't break again until March 28, 2013. (Investors would have broken even somewhat earlier, thanks to dividends.)

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On the other hand, markets generally hit new highs over time, and if you were to sell at each new high, you'd run a decent chance of missing further gains. Had you sold at the market's former all-time high of March 28, 2013, for example, you would have missed a 25% gain.

Traders on the floor of the New York Stock Exchange on April 11, 2014
Getty Images

New highs are the hallmark of a mature bull market, says Sam Stovall, managing director of U.S. equity strategy at S&P Capital IQ. It's the nature of bull markets to make new all-time highs — otherwise, the S&P 500 would never have gotten past 13.55 in June 1949, its first bull market high after the index started at 10.

The average bull market spends about 7% of its life at all-time highs, according to Stovall. This bull market has been at all-time highs about 5% of its life. In long-term, secular bull markets, such as those in the 1980s and 1990s, the market spends between 12% and 13% of its life at all-time highs.

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A new high, in and of itself, is probably a bad reason to sell. And there are lots of other bad reasons to sell, including:

• Politics. If you bought stocks because you thought George W. Bush would be a business-friendly conservative president, you were half right. He is a business-friendly conservative. But that doesn't mean stocks will fare well. From the day Bush was inaugurated to the day he left office, the S&P 500 lost 40%. Conversely, if you sold stocks because you thought Barack Obama was a kitten-eating Communist, you've missed a 143% gain so far.

US market still has upside: Pro
US market still has upside: Pro

• Pundits. Anyone who tells you to sell all your stocks isn't credible, even if he was lucky once.

• Friends. Your friend may, indeed, know that the financial system is going to collapse. Your friend may also know that he can get 537 cable channels from the fillings in his teeth. You just never know about people.

Being reluctant to sell, however, is never the same as never selling. And there are some very good reasons to sell stocks from time to time. Start with the basics:

• You've reached your goal. Let's say that your goal was to have $500,000 in your retirement account by age 65. Woo hoo! You're 60, and you have that now. If you were 70% in stocks, you can dial back. There's no need to take more risk than you need. Your main goal now will be to beat inflation — currently 2%.

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• You have more in stocks than you're comfortable with. Let's say you've decided that you're happiest with 60% of your portfolio in stocks. Thanks to the market's recent rise, you now have 70% of your portfolio in stocks. Nothing wrong with selling enough to get back down to 60%.

• You're investing in individual stocks in a taxable account, and you bought a stinker. You should seriously reconsider an individual stock if it's down more than 10% after you bought it. If it's down 20%, well, you were probably wrong, not early. Sell the stock, take the tax loss, and figure out what you did wrong. If you really were early, you can wait 30 days, purchase the stock again, and keep your tax loss.

What if you're simply uncomfortable with the market's current levels? After all, the Federal Reserve is cutting back its market-friendly bond purchases. Corporate profits are close to all-time highs. And as the economy improves, workers will start to get raises, which will squeeze profits sooner. Stovall says that the S&P 500 has already reached their estimate for 2014, although they expect a 7.5% gain in the next 12 months.

Two things: If you're really worried and can't sleep at night, consider letting your cash levels creep up to a level that keeps you from shrieking every 20 minutes. If you're a 401(k) investor, for example, you could direct new money into your money market option until it reaches a level that lets you breathe easy. If your worst fears come true, you'll have some buying power at the end of the next bear market.

Why stocks are a better bet than bonds
Why stocks are a better bet than bonds

Your main reason to buy stocks should be to get better long-term gains than you might expect from the alternatives: ultrasafe banks CDs and bonds. If you need to use your money next year for Bunky's college tuition, you shouldn't let Mr. Market decide how much you'll have. Put the money in safe investments, so you'll at least know how much you have to work with.

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If you're investing for the next 20 years, though, you shouldn't be overly concerned with what goes on in the next 12 months. For example, if you had invested in the S&P 500 at the start of the last bear market — the worst since the Great Depression — you'd have a 25% gain now, and a 45% gain including dividends. If you'd invested in three-month Treasury bills, you'd have a 2.7% gain.

Your best advice for your portfolio when the market's at an all-time high: Create a mix of stocks, bonds and money market securities that lets you sleep at night, check it once or twice a year, and spend the rest of your time worrying about more important things. For instance: Why is the ground shaking?

By John Waggoner, USA Today